Pittsburgh gives birth to tech firms, but can't keep them

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Call it the Goldilocks syndrome. There's less capital available to help businesses expand, and local startups that do win major funding often leave town to chase that elusive cash.

The result: Pittsburgh is left with few tech companies of "just right" size to create jobs and spin off business for the local economy.

The latest examples came in the past month when two local companies-on-the-verge -- social media site Lockerz and the online retailer ModCloth -- announced they would shift their headquarters to the West Coast after winning major funding there.

Economists call the period of working toward that rare middle-market size the "Valley of Death." Others say it's worse than your average adolescence -- "It's an adolescence where you can die," said Howard Wial, an economist at the Brookings Institute in Washington, D.C.

While Pittsburgh has proven good at giving birth to small tech firms, the city's effort to be an alternative to tech heaven Silicon Valley has been hurt by its difficulties in helping those young companies to mature. The recession has worsened the problem.

It's not about having few big public companies here, according to Michael Matesic; it's the lack of middle-market operations that strike a balance between large-scale operations and startups with a staff in the single digits

"Who in Pittsburgh is acquiring other companies in Pittsburgh? That's what I don't see enough of," said Mr. Matesic, the chief executive officer of the Idea Foundry investment firm in Oakland.

The most exciting local tech development of the past year came courtesy of an outsider, with Google announcing it would double its Pittsburgh footprint with a new office opening this summer.

Three months before that announcement, the massive search engine company announced it had acquired Carnegie Mellon University startup Recaptcha in a deal that vaulted the company to the big time and still makes young entrepreneurs salivate. More startling: Recaptcha stayed in Pittsburgh.

Growing a company to the point that it can sell stock on Nasdaq or the New York Stock Exchange can offer a real payoff to employees and the hometown, in addition to helping a business fund its own expansion. Even the Google staff masseuse made millions when the company went public; shares still hover around $450.

But going public hasn't been as enticing an option during the recession.

Google went public in 2004, a year that saw 218 IPOs. Last year saw 63 initial public offerings of stock -- not exactly a welcoming market.

"Times are tough so it's hard; you can't blame anyone for just saying, 'I'll try to get acquired,' " said Mr. Matesic.

The Pittsburgh region is home to a smattering of public tech companies, which saw a combined fiscal 2009 revenue of about $1.86 billion for five of those -- Black Box Network Services, Ansys Inc., II-VI Inc., Tollgrade Communications and Wizzard Software.

A sixth, DynaVox Inc., went public in April in a day of trading that saw shares open and close at $15.

Analysts say local tech momentum isn't coming from the public companies.

"Contrasted with Silicon Valley, the number of spin-offs from public companies didn't really happen here," said Kim Caughey, an investment analyst at Fort Pitt Capital Group in Green Tree. "No one is jonesing for Pittsburgh companies."

Instead, much of the attention is directed to hot startups out of Carnegie Mellon's Project Olympus or AlphaLab, the incubator program run by the Innovation Works nonprofit venture capital firm.

Programs like those help young companies lobby for attention from venture capitalists hunting for the Next Big Thing. But venture capital funding has also seen drastic drops.

Venture capitalists invested about $17.7 billion in 2009 -- down from the approximately $28 billion seen in 2008, according to the National Venture Capital Association. Though the first quarter saw a slight uptick in activity, analysts expect 2010 to hold steady.

Pittsburgh companies are not alone in the venture capital drought that's helping to keep companies in the Valley of Death, said Dr. Wial. And it's not a particularly new problem -- only one exacerbated by the recession.

The "increasingly reluctant," risk-averse venture capital community is forcing entrepreneurs to turn to more funding from sources like universities and nonprofits, he said.

But universities can help companies overcome growing pains only to a certain point.

"You can spin things off universities if you've got help with early-stage moves like getting patents, but you can't necessarily bring out a line of product that's going to be sustainable on your own," he said.

University programs provide advisers who stress the need to return liquidity to investors, said Frank Demmler, head of the Entrepreneurial Services Team at Innovation Works.

Sometimes acquisition is the easiest way to assuage nervous investors looking for a return.

"We seem to do a really good job of creating and growing acquisition candidates," said Mr. Demmler. "We need companies that can break through that threshold of being a stand-alone company that does not need to be acquired in order to provide liquidity to investors."

Innovation Works imposes a "transfer fee" of twice its investment on portfolio companies if they shift their headquarters from Pennsylvania within five years of receiving a grant. The average seed-funding investment for a portfolio company is $340,000 and can reach $600,000.

That transfer fee may be spare change compared to venture capital cash -- or to the moving fees that come with it. Venture capital funding lately has been great for local companies close to middle-market status but unlucky for their hometown.

Online retailer ModCloth has operated out of Pittsburgh since 2002, but the outfit announced this month its headquarters would move to San Francisco after Bay Area-based Accel Partners led ModCloth's investing funding of $19.8 million.

Lockerz, a 19-month-old survey website targeting a social media-savvy teen audience, has moved its headquarters and 30 employees to Seattle from its former home on Liberty Avenue. Its backers include Kleiner Perkins Caufield & Byers, a Silicon Valley venture capital firm. Twenty workers will stay in a Pittsburgh office for member services and merchandising.

"When we see companies pulled out of the region or acquired, that's a loss," said Mr. Matesic. "Maybe there's some wealth that gets recirculated."

It's not the first time Pittsburgh companies have followed the money.

Michael Mauldin developed the Lycos search engine at Carnegie Mellon in 1994, which in 1996 ended its first day of trading with a $300 million market value and in 1999 was the most-visited website in the world.

Despite cities like Pittsburgh and Cincinnati emerging as regional tech hubs, most of the activity and buzz still focuses on the coasts, Dr. Maudlin said. "There are economies of scale, and if you don't have a critical mass of venture capital, you could be a great source of innovation, but it's going to have to go somewhere else," he said.

Lycos' first chief executive was Bob Davis of Boston, who stepped in after Dr. Mauldin decided not to stay with the company after it went public.

As part of the transition negotiations, Dr. Mauldin wrote a contract clause that required the new management to maintain a Pittsburgh presence for five years.